Chesapeake Will Get Rid Of Voted-Out Directors When It's Good And Ready

Shareholder democracy is for the most part a very training-wheels sort of democracy. If you don't like the directors of your company, you can vote against them, but you can't vote for anyone else: if you want to nominate someone new, you generally have to run an expensive and time-consuming proxy contest, which for the most part is only a good idea if you're somebody who's in the business of running proxy contests. Absent that, voting against a director has the effect more of a tantrum than of an actual vote, since the general rule is that the candidate who gets the most votes wins, and if there's only one candidate and there's one vote for him and one hundred million against, he wins.

Richard Davidson and V. Burns Hargis must feel like winners today, since they got more votes than the next guy at the Chesapeake Energy annual meeting and so were re-elected as directors. Sadly, their celebration will be short-lived, because (1) Chesapeake also adopted a "majority voting bylaw" that provides that directors who get more votes against than for have to submit their resignations to the rest of the board, (2) three-quarters of shares that voted, voted against them, and (3) the board "will review their resignations in due course" but seems inclined to accept them in the coming “weeks, not months.”

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Actually, for a full taste of democracy in action, here's a rundown of the votes today:

I've highlighted in yellow the places where the board wanted one thing and the shareholders wanted the other thing. It is safe to say that, outside of boring stuff like ratifying the auditors, the board and the shareholders do not see eye to eye. When Citi's shareholders rejected Vikram Pandit's $15mm comp package in April, that sparked some introspection and rethinking of his pay. When CHK's shareholders rejected Aubrey's $17.9mm pay package, it didn't rate a mention in the Bloomberg article about the vote, or in the company's "we'll take it under advisement" boilerplate press release.

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Of course that's because there has beensomeunpleasantness at Chesapeake, which has led to investor dissatisfaction that cannot be addressed just by trimming comp, so more extreme measures have been taken. Specifically:

Half of the board’s eight non-executive directors are scheduled to be replaced by June 22 under an agreement announced this week with Southeastern Asset Management and Carl Icahn, which together control more than 20 percent of Chesapeake’s common stock. Icahn will appoint one of the new directors and Memphis-based Southeastern the other three. The chairman also will be announced in that time.

Is that not weird? I mean, not unusual, but still weird. Southeastern and Icahn own 13.9% and 7.6% of CHK, respectively, yet they got to pick four of the nine directors (eight non-execs plus Aubrey). They do that picking without any shareholder vote - CHK's bylaws, like most companies', allow the board to fill its own vacancies between elections, so all they have to do is agree to have four of them resign and the rest elect the Southeastern and Icahn nominees.

Among the other board-disapproved, shareholder-approved proposals in the proxy was one to let shareholders nominate directors to the board using the company's proxy. If that provision were in place already, Southeastern and Icahn could have nominated their directors publicly and had shareholders vote on whether they were better or worse than the current guys.* Since it wasn't (and won't be - the proposal is not binding on the board and they seem verrrrry unlikely to implement it), and since frankly negotiating for direct appointment of your candidates is more fun / better bang for the buck, they got their directors on the board the old-fashioned way: through negotiations with incumbent management that other shareholders were not privy to.

It seems pretty certain that the shareholder-led shakeup at Chesapeake will improve governance by shaking up an entrenched board, subjecting it to re-election each year, and creating some soft form of accountability in the requirement that a rejected director resign (though the remaining directors need not accept his resignation and, if they do, they still get to pick his replacement without shareholder input). But it's also a good reminder that shareholder democracy, day to day, functions mostly as symbolism: dispersed public shareholders have limited power, and even their beefed-up protections in the New Chesapeake don't give them any actual ability to replace directors, change bylaws, or do much of anything else.

The power standing behind these shareholder protections is more subtle. A small part of it is that disgruntled shareholders can dump the stock, pushing down the net worth of management (and, sometimes, triggering margin calls). A bigger part, though, is that disgruntled shareholders are more likely to be receptive to people who are in the business of running proxy fights - or hostile takeovers. The 75% of shareholders who are fed up with Chesapeake's governance prepared the ground for Icahn to take action with his 7.6% stake, but there's a reason his 7.6% got more done than their 75%.

* This is a little oversimplified. The proposal requires you to have been a 3% shareholder for three years to nominate a director, so Icahn's new stake probably disqualifies him. And Chesapeake, under Oklahoma law, has a staggered board so you couldn't replace four directors at once in the ordinary course (though you could if the old guys resigned). As part of the Southeastern/Icahn better-governance deal, Chesapeake plans to "seek relief from the Oklahoma statute mandating classified boards of directors for certain Oklahoma incorporated public companies so that shareholders will have the opportunity to elect the entire board of directors at the 2013 Annual Meeting of Shareholders."